Friday, June 14, 2013
Do the tax benefits outweigh the costs?
Do the tax benefits outweigh the costs?
When you purchase permanent life insurance, part of your premium goes into a cash value account that can grow based on policy dividends, interest, and/or earnings from mutual fund-like sub-accounts. Each policy is different so make sure you understand the particulars of how it works before you buy it (like any investment). The main advantage is that you can borrow from this cash value for things like retirement or education expenses without paying taxes on it.
So what’s not to like? First, some of these sub-account investments involve risk and you may be required to add additional dollars to keep the policy going if the investments don’t do well. There’s a good chance that will be during tough economic times when extra money might be scarce. Second, there are a lot of fees and expenses that could eat quite a bit into your returns so make sure you know what all those costs are.
To figure out whether it’s a good deal for you, compare it to purchasing a lower cost term policy and investing the premium difference somewhere else like your 401(k) or an IRA. For example, a recent Helpline caller said that she was quoted an annual premium of about $8,700 for a permanent policy. She could purchase the same amount of term insurance for 30 years for only about $700 a year. If the investments in the permanent policy earned 8% over 30 years, it was projected to grow after expenses to about $600,000, some of which could be borrowed tax-free. That sounds great but investing the $8,000 difference in a Roth 401(k) with the same 8% return (but without the higher expenses) would provide her about $980,000 all tax-free after 30 years. I don’t know about you but I could certainly use an extra $380k for my retirement.
As you can see, the benefits of using permanent life insurance as an investment can be significantly outweighed by the costs. It’s always a good idea to run the numbers for yourself though because each person’s situation is different. For example, if you’re in a very high tax bracket and you’ve maxed out all your retirement plan contributions, the tax benefits of a permanent life insurance policy would be more valuable to you.
It’s also important to note that I’m not saying that your adviser is trying to “scam” you if they recommend a policy that ends up not being worth it. This is the difficulty of being a financial adviser on a commission. As the saying goes, when you’re a hammer, everything looks like a nail. Your adviser may just be doing their job in the best way they know how. It just means that you may also want to get a second opinion from an unbiased source. On that note…
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Dennis Cunning Steve Toth Randall Smith Paul Kaplan Herb Green Casey Hermansen
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